South Dakota urges Supreme Court to click 'buy' on internet sales tax

The Supreme Court is pictured in Washington
Thomson Reuters
By Lawrence Hurley

PIERRE, South Dakota (Reuters) - The woman walked into Cash Hogen's hardware store last fall to ask a single question about a KitchenAid mixer on display: What did the manufacturer call that color scheme?

"Tangerine," replied Hogen. And with that, the woman walked out.

It is a kind of customer interaction that happens often these days, said Hogen, who has run his store in Pierre, South Dakota's downtown historic district since 1983.

People come in to look at a product, ask a question or two, then leave, presumably to search for it more cheaply online. Retailers even have a name for the practice: "showrooming." "It's just a gut feeling that she's not buying it from me," he said.

One reason customers shop elsewhere, Hogen says, is that even when he can compete on price, he has to charge sales tax, which ups the ultimate price of his merchandise. The mixer, for example, normally has a $399.99 price tag in Hogen's store, on top of which he has to charge $26 in state and local sales taxes. Some online retailers sell the mixer at the same price or lower, with no sales tax and free shipping.

That sales tax differential is at the core of a case that will come before the U.S. Supreme Court on April 17, and the stakes are high not only for store-keepers like Hogen, but also for online retailers, for state governments and for bargain-hunting consumers.

The case stems from a South Dakota law passed in 2016 by legislators at the state capitol building a few blocks from Hogen's store that requires out-of-state online retailers to collect state sales taxes.

The state enacted the law knowing it would be challenged, due to a 1992 Supreme Court ruling in the case of Quill Corp v. North Dakota, which held that states cannot require retailers to collect sales taxes unless they have a "physical presence" in the state.

Passing a law certain to draw fire was "the nuclear option," said Republican state Senator Deb Peters, a prominent supporter of the measure, but legislators considered it necessary as internet sales continue to rise.

After the law was enacted, the state preemptively sued four online retailers. Overstock.com Inc, Wayfair Inc and Newegg Inc contested the lawsuits, while the fourth company, Systemax Inc, decided not to. After losing in lower courts, South Dakota appealed to the Supreme Court, which announced in January it would hear the case.

The state will argue that the legal precedent dates back to the days of catalog sales and is no longer relevant in the internet age. [nL1N1P71SZ]

A ruling in favor of South Dakota could funnel up to $13 billion a year of new tax revenues into the coffers of affected U.S. state governments, according to a 2017 federal government report.

It would also make it harder for consumers to find deals online where they can avoid paying sales tax.

Hogen is following the Supreme Court action, but while a favorable ruling for the state might help him, he said, he knows a single court ruling cannot reverse the e-commerce trend.

"If this sales tax thing goes through, it's not going to end internet shopping," he said. "That's here to stay."

"PHYSICAL PRESENCE"

The rugged, rural, Republican-led state of South Dakota is notoriously stingy when it comes to spending taxpayer dollars. It has no income tax and relies heavily on sales taxes for revenue.

The state estimates it loses up to $50 million a year in sales tax on internet purchases, which now account for 8.4 percent of sales nationwide, according to U.S. Census Bureau data.

The new law requires out-of-state online retailers to collect sales tax if they clear $100,000 in sales to South Dakota residents or have 200 separate transactions with customers in the state.

Wayfair, Overstock and Newegg did not respond to requests seeking comment. Amazon.com Inc, the dominant internet sales company, has not taken a position in the legal battle and declined to comment for this story.

Amazon has already agreed to collect sales taxes in all 45 states that impose them. The company has not generally collected taxes for items sold on its website by third party vendors, which constitute about half of total sales on the platform, although two states have now enacted laws to require it to do so.

The South Dakota law does not directly affect some other large online retailers, such as Walmart Inc. and Macy's Inc., because they have brick-and-mortar stores in the state and so were already required to collect sales tax.

Other states have also wrestled with how to collect out-of-state taxes from e-tailers, including New York, which passed a law in 2008 that sought to stretch the definition of "physical presence" without running afoul of the Supreme Court precedent.

The amount of money states stand to gain from taxing online sales is uncertain. A widely-cited 2009 study by the University of Tennessee, updated in 2012, estimated that $23 billion a year in state and local revenue was being lost nationwide to internet commerce in 2009 and would increase every year.

But data from states that have tried to capture online sales tax revenue suggest that number may be high.

In New York, for example, the state has said in court papers that between the 2008 passage of its law and February 2012, e-tailers remitted $360 million in sales tax. The University of Tennessee study had estimated that, by 2012, New York could collect nearly twice that amount in a single year by applying state and local sales taxes to internet purchases.

In fiscal 2017, South Dakota took in just over $1.4 billion in sales taxes, according to the state's Department of Revenue, which accounted for 71.7 percent of the state's total revenue.

Only Washington state and Tennessee have a higher proportion of sales tax to total tax revenue, according to the Tax Foundation.

Despite South Dakota's predictions of major gains, Governor Dennis Daugaard acknowledged in an interview that "it's really quite difficult to know" exactly how much additional revenue the state will gain if it wins at the Supreme Court.

KENNEDY'S ROLE

The impetus for South Dakota's law came from one of the nine people who now hold its fate in their hands: U.S. Supreme Court Justice Anthony Kennedy.

In a 2015 opinion on a related issue, Kennedy questioned the continuing relevance in the internet age of the 1992 Quill ruling that only sellers with a physical presence in a state could be required to collect sales taxes. He urged those with a stake in the issue to "find an appropriate case for this Court" to reconsider the earlier precedent. A ruling in the case is due by the end of June.

Carl Szabo, general counsel of NetChoice, an e-commerce trade association urged the court to defer to Congress on the issue, stressing the complexities of allowing states to collect taxes nationwide.

"One of the fears I have is that there's nothing to limit small businesses from being inundated by demand letters from tax collectors around the country," he said.